Even some of Wall Street’s biggest bulls are tapping the brakes. Veteran strategist Ed Yardeni has pushed his S&P 500 target of 8,400 out to mid-2027 as bond yields climb. 

The jump in yields makes bonds more competitive with stocks while weighing on future growth expectations.

That shift says a lot about the mood under the surface. President Donald Trump picked Kevin Warsh to lead the Fed hoping for lower rates, yet just months into the job, Warsh is overseeing the central bank’s first rate hike since 2023.

Warsh credited a strong economy, competition for capital, and geopolitics for rising yields. The latest Fed minutes suggest he isn’t finished.

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Fed minutes point to another hike before year-end

The minutes released on Oct. 7 showed that every Fed participant, not just the voting members, backed the Sept. 16 rate increase. Most of them also judged that another hike would likely be appropriate by year-end, and Fed staff projected that inflation would not return to the 2% goal until 2029, according to the Fed.

Fed Governor Christopher Waller offered a window into that thinking in remarks prepared for the Istanbul Economic Forum on Oct. 8. He pointed to energy costs tied to the Iran war, rising tech prices driven by the AI build-out, and looming trade tariffs as forces that have stalled progress toward the Fed’s target.

Waller’s biggest worry is psychological. He fears the recent acceleration in inflation will lead consumers and businesses to expect higher prices down the road, while saying he is not greatly concerned that tighter policy will trigger a damaging slowdown. A New York Fed survey released Oct. 7 showed one-year inflation expectations at their highest level since 2023.

Wall Street is taking the hint. J.P. Morgan chief U.S. economist Michael Feroli expects one more hike at the December meeting, noting that core PCE inflation has topped 3% every month this year.

Because he sees inflation as mostly supply-shock driven, he doesn’t expect a long hiking cycle stretching into next year, according to Reuters.

The Fed also sees AI as an inflation story, not just a growth story.

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The AI build-out is running on borrowed money

Here’s where things get uncomfortable for the market’s favorite theme. Asked about rising Treasury yields after the Fed’s Sept. 16 decision, Warsh said hyperscalers raising money in the bond market partly explain the move, adding that “the competition for capital is real,” Fortune reported.

The scale is hard to ignore. Morgan Stanley estimates AI-related global debt issuance will approach $570 billion this year. Not everyone agrees on the impact, with PIMCO arguing that the Iran war matters more for Treasuries than AI borrowing does.

The Fed also sees AI as an inflation story, not just a growth story. Staff tied part of the recent rise in inflation to technology-related consumer goods linked to the AI build-out, while some officials warned AI investment could push demand ahead of supply.

Energy prices, lifted by conflict in the Middle East, were another central concern, according to the Fed.

Fed Governor Lisa Cook made a similar point in a Sept. 28 speech. She said AI appears to be adding inflation pressure in the short term, postponing the return to the Fed’s goal. She also said the labor market appears well positioned to handle an increase in rates.

Cracks are starting to show in the AI trade

Investors recently got a reminder of how fragile sentiment has become. The Financial Times reported that OpenAI told investors its annualized revenue was approaching $50 billion at the end of September, well below the roughly $70 billion figure that had been widely circulating in press reports, Bloomberg Tax noted.

The market didn’t wait for an explanation. Nvidia, Oracle, and Micron all fell on Oct. 8 as investors questioned whether AI revenue justifies the money pouring into chips and data centers.

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For now, the biggest spenders look well cushioned. Hyperscalers account for the bulk of U.S. AI investment and have shown little sensitivity to higher funding costs so far. Smaller firms are more exposed, and the bank warned that persistently elevated yields could limit stock market upside.

Valuations tend to feel higher rates first. Yardeni also lowered the forward price-to-earnings multiple he expects for the S&P 500 at year-end, citing the recent backup in bond yields.

He now sees the index ending 2026 at 7,900 rather than 8,400, International Business Times reported.

What investors should watch next

Vanguard global chief economist Joe Davis believes short-term rates would likely need to rise above 5% before earnings take a serious hit, and that isn’t his base case. Still, the longer-term yields that drive everyday borrowing costs have already crossed that line.

Right after the September meeting, most major brokerages expected the next hike to come in December, while BofA Global Research stood out as the only one calling for two more increases this year.

Citigroup was the lone holdout expecting no change, Reuters reported.

The next test arrives with the September consumer price index on Oct. 14. Goldman Sachs warned that if inflation keeps rates elevated, its gloomier scenario for the economy becomes increasingly relevant.

If yields begin to retreat instead, the bank said the economy has more room to keep expanding.

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